Venezuela: The EMD play that's not for the faint hearted

It’s not every day that an intern risks bringing down an entire country’s economy.

But for Venezuela, which stopped paying bondholders for seven months without telling anyone, this is nearly what happened.

The South American country’s troubles do not stop there – with a socialist dictatorship at the helm, an economy in ruins and inflation at 4,000%, there is much to consider.

Despite this, a surprising number of emerging market debt (EMD) managers are still keen on the country’s prospects.

The government, led by controversial president Nicolas Maduro (pictured), has been accused of ‘hoodwinking’ investors after its central bank published data in April that accidentally revealed regular debt payments to foreign bondholders fell to the low tens of millions.

The country is still paying out on bonds from the state-owned oil company PDVSA and electricity firm Elecar, but data from Caracas Capital, which specialises in Latin American debt, showed $83 million (£63 million) was paid in October last year, compared to sovereign obligations of $465 million.

This went down to $23 million by December, compared to obligations of $242 million.

It is believed that the data, which showed the monthly spend figures in US dollars on foreign debt obligations, as opposed to the previous format of a ratio which revealed far less information, was posted by an intern at the central bank.

Russ Dallen, founder of Caracas Capital, originally broke the news of the ‘stealth default’ to his clients, and believes the outlook for short-term bondholders is rather bleak.

He said: ‘Venezuela has $65 billion outstanding for bonds and it’s a game of musical chairs; the first ones there are filing lawsuits, seizing whatever assets they can.

‘With PDVSA bonds you can go after assets, but with sovereign bonds it’s much harder to go after Venezuelan assets.’

Some investors, however, are playing the long game in Venezuela and see the opportunity to potentially strike gold further down the line in a country that, back in the 1970s, was AAA-rated by rating agency Moody’s.

The long game

One such investor is Citywire AA-rated Claudia Calich, manager of the M&G Emerging Markets Bond fund. She has 1.15% of her fund in Venezuelan bonds, particularly in sovereign and PDVSA bonds with 10 to 15-year maturities.

She said: ‘The valuations from a very long-term perspective look interesting. Some bonds there are trading at 23, 24, 25 cents to the dollar, and sovereign bonds are trading at 27-29 cents.

‘If you look at other countries that have restructured their debt over the last couple of decades in emerging markets, the money that creditors actually receive ranges from 30 cents to 70-80 cents on the dollar, so there are long-term recovery values there.’

Of course, any hope of a major debt restructuring in Venezuela, and actual economic reform, seemingly rests on a change of government.

To some, this would appear unlikely to happen in the foreseeable future, but Uday Patnaik, head of emerging market debt at Legal & General Investment Management (LGIM), believes the Maduro regime could fall by the end of this year, with a more market-friendly, pro-Western regime taking its place. He too holds Venezuelan sovereign bonds.

He said: ‘I’m very sceptical this regime will last. That is the goal of the US sanctions. There’s also a massive problem with the refugee crisis, with Venezuelans migrating to Colombia and other countries in the Americas.

‘They want this government to end as well, so the military would undoubtedly be involved in any regime change, and it’s in their interests too to gain FDI [foreign direct investment] and for the US sanctions to be removed.’

Patnaik is also upbeat on valuations in the event of a debt restructuring, with LGIM’s models showing restructuring values of 45-65 cents on the dollar for Venezuelan sovereign bonds.

He added: ‘The upside is tremendous, assuming we have a regime change. That’s the reason we have exposure. The big question is, am I right?

‘The downside is probably 18-20 cents on the dollar, unless Venezuela goes in the direction of Cuba or North Korea where it would go lower, but I don’t see that happening. I believe the regime will end.’

Indeed, the expectation of regime change is something echoed by Colombia’s president, Juan Manuel Santos, who told a meeting of business leaders in Hungary last month he believes a regime change ‘will come very soon’, after which the Venezuelan economy will ‘take off very fast’.

Dallen, a specialist in Venezuelan debt, sees the sense in investors holding out, especially if a new regime can harvest the opportunities the country provides.

He said: ‘That’s the long-term play. It’s important to remember this is not a solvency crisis, it’s a liquidity crisis. Venezuela has the largest oil reserves in the world. They have trillions of dollars in the ground, but isn’t getting it out.

‘That’s the bet, that the regime changes and Venezuela eventually returns to the international capital markets to develop its vast resources, not just oil. It has the fourth largest gold reserves in the world but is not producing anything from gold right now. It also a lot of iron ore, copper, strategic metals, diamonds and emeralds.’

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